Robert Feinberg: Dodd-Frank: Too Far or Not Far Enough?

At a conference on the Dodd-Frank Act sponsored by the Center for Law, Economics and Finance of the George Washington University Law School, a panel of four experts considered the question of how effective Dodd-Frank might be. Two of the panelists represented two of the federal banking agencies that have serially failed to take effective action to prevent the financial crisis from growing to a size where it could threaten the U.S. and global economies. Scott Alvarez, general counsel for the Federal Reserve Board of Governors, and Richard Osterman, acting general counsel of the FDIC, recited the provisions of Dodd-Frank that now, finally, bestow upon their agencies the powers they lacked that supposedly prevented them from acting effectively to contain episodes of the ongoing financial crisis.

At a hearing of the Senate Banking Committee, Federal Reserve Chairman Ben Bernanke testified that the alternative to bailing out the largest banks would have been “to treat them as supervisory cases.” In other words, for the Fed to do its job. Former Fed Vice Chairman Alice Rivlin testified that the argument advanced by the Fed that it needs to be involved in bank supervision because it enables the Fed to do a better job of formulating monetary policy is not substantiated by an examination of minutes of the Federal Open Market Committee, where banks supervision is rarely, if ever, discussed.

Former Sen. Chris Dodd, D-Conn., who was chairman of the Senate Banking Committee, had proposed removing this power from the Fed because the Fed had failed for 14 years, from 1994 to 2008, to implement legislation that gave the Fed the power to regulate the underwriting practices of banks — an action that could have prevented banks from making loans to borrowers who lacked documentation and the ability to repay.

As for the FDIC, in 1991, the FDIC Improvement Act gave the agency the power to take “prompt corrective action” to keep banks from operating in an insolvent condition that would leave taxpayers with losses when those institutions failed. The FDIC failed to implement this, and it also failed to maintain sufficient funds to meet the statutory requirements and will not even begin to do so until 2018.

So the presentations of the two general counsels left the audience with two questions. If these agencies have never implemented their powers to prevent the excesses of banks from imposing costs on taxpayers in the past, what makes anyone think they will do so in the future? Second, does it make sense to confer new powers on regulators that have assiduously failed to do their jobs?

The real debate over the import of Dodd-Frank broke out between Peter Wallison, a Fellow at the American Enterprise Institute for Public Policy Research, and Dennis Kelleher, CEO of Better Markets, a nonprofit organization that promotes the public interest in financial reform in domestic and global capital and commodity markets.

The debate got off to a promising start when Wallison told the audience it was always a pleasure to participate in a panel with the two general counsels. When it was Kelleher’s turn, he said it was likewise a pleasure for him to participate with the two general counsels. These two know each other very well.

Wallison made it clear that he believes Dodd-Frank goes too far. Title I designates 36 bank holding companies as systemically significant, and four nonbanks stand also to be designated. He complained that the regulators will have the power to take over functions of these institutions and that instead of ending the policy of Too Big To Fail, Dodd-Frank actually codifies it. He explained this happens because once financial institutions receive the designation of a bank holding company, creditors will assume they are backed by the federal government, and they will be able to borrow more cheaply than their competitors will.

Moreover, Title II authorizes the FDIC to establish a so-called “bridge bank” to keep the franchise of a large failing bank alive until it can be restructured and sold, and the Treasury will provide the funding for this enterprise. Supposedly, the cost of this procedure will be recouped from the banking industry.

The banking industry is complaining that the Volcker Rule, which prohibits banks from trading for their own accounts except for underwriting and market making, fails to define these activities.

Regulators have also failed to issue rules on what types of mortgages can be made under provisions of Dodd-Frank designed to protect borrowers and to require originators of mortgages to retain “skin in the game” when the mortgages are sold to investors.

Wallison observed that the industry is trying to deal with “costly and troublesome” requirements, including over-the-counter derivatives being subject to clearing and margin by shifting the transactions from the swaps to the futures markets. Wallison concluded that Dodd-Frank is “an unworkable statute,” and he called for its repeal, protesting that the financial crisis was not caused by the banks.

Kelleher responded that Wallison ignores that the government guarantee the banks enjoyed became implicit during the crisis, so that the largest banks were bailed out by the federal government.

In the meantime, the banking industry’s lobbyists have worked to change the focus of the debate from the industry’s role in the crisis to the burden Dodd-Frank places on the industry. Rarely mentioned is the $12.8 trillion cost of the crisis to the economy, which he said his organization has documented in a special report.

He accused the industry of using a variety of delaying tactics to nullify Dodd-Frank while it pursues repeal of the statute. He questioned why, two years after the enactment of Dodd-Frank, most of the regulations intended to protect the public from future crises still have not been promulgated, but the industry, now backed by the government, has paid out $94 billion in bonuses.

Kelleher called the so-called “toxic” securities that the government has helped to fund “worthless.” As opposed to Wallison’s call for repeal, Kelleher called for the regulators to proceed to implement it and to impose the costs on the industry.

At a conference on the Dodd-Frank Act sponsored by the Center for Law, Economics and Finance of the George Washington University Law School, a panel of four experts considered the question of how effective Dodd-Frank might be.